Corporate Governance 2024 (Japan Chapter) - Trends And Developments

Introduction

One of the topics related to corporate activity that attracted the most attention in Japan in 2023 was the 31 March publication of three notices addressed to listed companies by the Tokyo Stock Exchange ("TSE"). 

The notices were entitled (1) "Action to Implement Management that is Conscious of Cost of Capital and Stock Price"; (2) "Better Dialogue with Shareholders and Related Disclosure"; and (3) "Using 'Explain' to Contribute to Constructive Dialogue"; and each addresses important issues relating to corporate governance in Japanese listed companies based on the discussions of the Council of Experts Concerning the Follow-up of Market Restructuring established by the TSE.

In particular, from the viewpoint of implementing management that is conscious of cost of capital and stock price, the first notice, "Action to Implement Management that is Conscious of Cost of Capital and Stock Price" (the "Notice") requests that all listed companies on the TSE's Prime and Standard Markets conduct a series of ongoing measures, starting with gaining a proper understanding of their cost of capital and profitability, based on their balance sheet, and then continuing with:

• analysing and assessing the current situation around these and the market valuation at board meetings;
• preparing and disclosing plans for improvement; and
• communicating with investors to update them on the progress of these efforts.

This request by the TSE was seen as targeting companies with a price-to-book ratio (PBR) below 1, and received significant public attention. Furthermore, each company's actions in response to the request by the TSE have also drawn considerable interest from stakeholders, particularly during the phase of engagement with shareholders.

The Guidelines for Corporate Takeovers (the "Guidelines") published by the Ministry of Economy, Trade and Industry (METI) in August 2023 were also of huge significance. The outline of the draft guidelines before their release was discussed in our  2023 contribution to this publication. The Guidelines were formulated following discussions by the council of experts established at the METI with the purpose of presenting principles and best practices that should be shared throughout the economy to develop fair rules regarding M&A transactions, with a focus on how parties should behave in the context of acquiring corporate control of a listed company, and they have greatly affected the board of directors' code of conduct in M&A transactions. One of the most notable impacts the Guidelines have had on the Japanese market has been the increase in so-called "acquisitions without consent". (An acquisition without consent is one that is conducted without prior consultation with the target company. Formerly known as a "hostile takeover" or "hostile acquisition," the Guidelines proposed renaming it as an acquisition without consent since it is not necessarily hostile, and the new term quickly gained widespread traction after the Guidelines were established.) The Guidelines provide that, even in the absence of prior approval of the target company, the latter's board of directors must give proper consideration to a deal proposal if a bona fide offer has been made. Traditionally, hostile takeovers have never been viewed in a positive light in Japanese business circles. However, several instances of companies conducting acquisitions without consent occurred in 2023 triggered by certain factors that included the publication of the Guidelines. This trend is expected to be more than just a temporary phenomenon, marking an epochal shift not only in Japan's M&A landscape, but also in corporate governance practices.

In view of the above, this article presents an outline of the Notice and the trends observed around acquisitions without consent since the publication of the Guidelines.

Outline of the "Action to Implement Management That Is Conscious of Cost of Capital and Stock Price"

According to Japan's Corporate Governance Code, which was published by the Financial Services Agency and the TSE in 2015, and subsequently revised twice, management teams needs to be able to allocate resources with sufficient consideration of cost of capital and profitability if their companies are to be able to meet the expectations of investors and other stakeholders, achieve sustainable growth, and enhance corporate value over the medium to long term. Listed companies in Japan have subsequently been making efforts to raise management's awareness of cost of capital and profitability, such as setting return on equity (ROE) targets in management plans. However, according to the Notice, as of 31 March 2023, approximately half of the listed companies on the Prime Market and 60% on the Standard Market have an ROE below 8% and a PBR below 1, indicating profitability and growth-potential issues. In response, the Council of Experts Concerning the Follow-up of Market Restructuring pointed out the need for reform in the thought processes of management to be more conscious of cost of capital and stock prices in order to improve companies' corporate value in the future.

Acknowledging the issues mentioned above, the Notice summarises measures to implement to achieve this and requests that listed companies actively implement these. The Notice explains the purpose of its request as follows.

"The purpose of these actions is to have the management of the company carry out their management duties with more consideration of cost of capital and profitability based on the balance sheet, rather than just sales and profit levels on the income statement, in order to achieve sustainable growth and increase corporate value over the mid- to long-term.

Specifically, in accordance with the basic management policy established by the board of directors, the management team is expected to take the lead in appropriately allocating resources with sufficient consideration of cost of capital and profitability. This can be done by pushing forward initiatives such as investment in research and development and human capital, leading to the creation of intellectual property and intangible assets that contribute to sustainable growth, investment in equipment and facilities, and business portfolio restructuring..." (here, the TSE is not necessarily expecting companies to use only share buybacks or dividend increases to improve profitability or solve issues on a one-off basis, but expects efforts at fundamental level to help achieve profitability in excess of cost of capital on a sustained basis and to result in sustainable growth).

"In taking these initiatives forward, companies are expected to enable investors to assess their progress by presenting clear information on related policies, targets, and specific details in whatever way they see fit, and to gradually improve their initiatives through proactive dialogue with investors based on this disclosure".

For the above purpose, the TSE requests that all companies listed on the Prime and Standard Markets implement the following actions on an ongoing basis.

Analysis of the current situation

• Gain a proper understanding of the company's cost of capital and profitability.
• Analyse and evaluate the current situation around these and market valuation at board of directors' meetings.
  • The TSE presents two questions to answer in the analysis and assessment section: (1) has the company achieved profitability that exceeds its cost of capital and, if not, the reasons why; (2) even if the company has achieved the above, if its market valuation is not high enough (eg, PBR less than 1), the reasons why.

Planning and disclosure

• Have the board of directors discuss and develop policies, targets, planning periods, and specific initiatives for improvement.
• • In particular, PBR is referenced with regard to policies and targets. The Notice specifically states that a PBR below 1 is one indication that the company has not achieved profitability that exceeds its cost of capital, or that investors are not seeing enough growth potential. On the other hand, if the PBR ratio is already above 1, companies could set targets for further improvement.
• Disclose clear information on the details discussed and developed at the board of directors' meeting, along with assessment of the current situation, to investors.

Implementation of initiatives

• Push forward with management that is conscious of cost of capital and stock price, based on the disclosed plans.
• Engage in proactive dialogue with investors based on this disclosure.
• The TSE requests that companies, after the implementation of Planning & Disclosure, update the disclosure at least once a year after analysing the progress of initiatives and results to date (although there is no specific timeframe for updates, TSE expects prompt updates to the content of disclosures if there are any major changes to plans that are already disclosed). In addition, when updating the disclosures, the TSE expects companies to present the progress of current initiatives and progress toward achieving targets, information on dialogue with investors, and any changes in targets and initiatives in a manner that is easy for investors to understand.

TSE has also started publishing the status of disclosures in response to the request made in the Notice. The most recent publication was made on 15 January 2024, and shows that, as of 31 December 2023, 49% of Prime Market listed companies (815) and 19% of Standard Market listed companies (300) have disclosed some kind of information (including companies whose disclosure status is "under consideration"). While some companies have disclosed their actions in response to the request made in the Notice, statistics reveal many companies' struggles to respond effectively to such a request, underscoring the significant impact of the Notice. It is anticipated that discussions and actions relating to the Notice will remain an important focal point among stakeholders in 2024.

Trends in Acquisitions Without Consent Following Publication of the Guidelines for Corporate Takeovers

As mentioned, the Guidelines were formulated with the purpose of presenting principles and best practices that should be shared throughout the economy to develop fair rules regarding M&A transactions, and includes acquisitions without consent within its scope. According to the Guidelines, generally, upon receiving a proposal containing a specific acquisition offer which seeks to gain control over the management of a company, including an offer of acquisition without consent, the offer must be submitted to the target company's board of directors for deliberation, and the directors and the board of directors (including, if applicable, the special committee established by the target company) should determine whether the acquisition proposal will increase the company's corporate value, and make reasonable efforts to ensure that the acquisition is conducted under terms and conditions which benefit ordinary shareholders.

Since the publication of the Guidelines, acquisitions without consent have risen at an unprecedented pace. We have summarised two major cases of acquisitions without consent, as follows.

Case 1: Takisawa Machine Tool Co., Ltd.

On 13 July 2023, Nidec Corporation ("Nidec") announced the launch of a tender offer for shares of Takisawa Machine Tool Co., Ltd. ("Takisawa"). This proposal was made without prior consultation with Takisawa, and is considered an attempt at acquisition without consent (as background information, Takisawa had received a capital and business alliance proposal from Nidec back in January to March 2022, which Takisawa had rejected).

Subsequently, Takisawa and Nidec exchanged, among other things, a list of necessary information in order for Takisawa to evaluate the feasibility of implementing takeover defence, and held in-person meetings.

On 13 September 2023, Takisawa announced its support of the tender offer by Nidec, and recommended its shareholders tender their shares.

On 14 November 2023, Nidec announced that the tender offer had been successfully completed.

Case 2: Benefit One Inc.

• On 14 November 2023, M3, Inc. ("M3") announced that it planned to launch a tender offer for the shares of Benefit One Inc. ("Benefit One") to make Benefit One its consolidated subsidiary, and Benefit One announced that it supported the tender offer. Note, however, that Benefit One then left its shareholders to decide whether they wished to tender their shares, deciding against making a recommendation. This is a common response in the case of a tender offer aimed at making the target company a consolidated subsidiary but keeping it listed, instead of making it a wholly owned subsidiary, which can only be achieved via a delisting.)
• 7 December 2023 – Dai-ichi Life Holdings, Inc. ("Dai-ichi Life") announced that it planned to launch a tender offer on the shares of Benefit One to make Benefit One a wholly owned subsidiary. Like Nidec's proposal to Takisawa, above, Dai-ichi Life's proposal was also that of an acquisition without consent. Benefit One announced on the same date that it would publish its opinion after reviewing the tender offer proposal by Dai-ichi Life.
• 8 February 2024 – Benefit One announced its support for the tender offer by Dai-ichi Life and recommended that the shareholders tender their shares. It then also announced on the same date that it had changed its opinion on the tender offer by M3, and that it would refrain from giving an opinion.
• On 1 March 2024 – M3 and Benefit One announced that the number of shares tendered in the tender offer by M3 fell short of the minimum number of shares to be purchased, and that the tender offer was unsuccessful.
• 12 March 2024 – Benefit One announced that the tender offer by Dai-ichi Life had successfully completed.

Historically, hostile takeovers were considered taboo in Japan. In recent years, however, there has been a gradual shift towards their use. A notable trend observed since introduction of the Guidelines is that companies seem to increasingly view acquisitions without consent more positively, and as a viable option, the above two cases being an example. Consequently, other parties involved, such as financial institutions providing funds, are also adjusting their stance towards the transactions.

What is interesting about the two cases mentioned above is that, although both proposals were initially made in the form of acquisitions without consent, the target companies ultimately decided to support the transactions proposed by the companies initiating the acquisition without consent. In the case of Benefit One, the target company changed its opinion on the transaction with M3, which it had once agreed to and made public, and then agreed to the transaction with Dai-ichi Life. This is thought to be as a result of serious consideration at the target company, focusing on enhancement of corporate value and improvement of shareholder interests, and the code of conduct for directors in response to acquisitions without consent as stipulated in the Guidelines is considered to have had substantial influence. The Guidelines not only had significant impact on M&A transaction practices in general, but also profoundly influenced the roles and responsibilities of directors, and contributed to a noteworthy development in corporate governance practices in Japan.

Several cases of acquisitions without consent have already been seen since the beginning of 2024, these types of transaction are expected to continue to increase.

Originally published by Chambers and Partners.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.